Who really owns a company? Directors duties and how to stay out of jail!

I have just spent a very enjoyable two days in Dublin, working with clients in the Irish sports sector.  It’s always good to be back ‘home’, and Friday, in particular, was a historic day as Ireland voted by referendum to become the first country in the world to embed civil partnerships in its Constitution.

This is also a significant moment for Irish companies as the Companies Act 2014 goes ‘live’ on 1 June.  As with the Companies Act 2006 in the UK, this was the largest piece of legislation ever to reach the Statute Book.

The two sports clients are each a Company Limited by Guarantee (CLG), a vehicle often used by ‘not-for-profit’ organisations, where any profits are fed back into the organisation rather than distributed to the members.  So, although these sports bodies are not traditional listed companies, we still spent a lot of time discussing the issue set out in the title of this blog.

Who really owns a company?

The simple answer to the question is that a company is a ‘legal person’ which exists separately and independently of its directors, officers, shareholders (or in the case of a CLG, its members), or other human persons with whom the legal entity interacts.  This is not a theoretical or philosophical statement, but a powerful and important legal reality.

The outcome of this reality is that directors owe their principal duty to the entity, and not to the members or shareholders.  This is because these members or shareholders do not own the company, nor the assets of the company;  they ‘merely’ own shares which represent bundles of intangible rights, which (usually, depending on the legal jurisdiction) include the right to vote on limited issues (such as the election of directors to the board).

There are practical consequences of this situation, and with my sports body clients we discussed important principles such as their fiduciary duty (to act in good faith and in the best interests of the company, and use the company’s powers conferred for the proper purpose), and their duty to act with due skill, care and diligence.

Sources of information

When I was Policy Director at the Institute of Chartered Secretaries and Administrators, we published a very useful Guidance Note on these issues, which you can access at www.icsa.org.uk (though you might have to become a member first).  I wanted to call the Guidance Note ‘How To Stay Out Of Jail’, but settled in the end on the more prosaic ‘Care, Skill and Diligence’.  It is difficult to exaggerate the importance of the content covered in this Guidance Note, and all directors should read it carefully.  

Another useful source of information on the issue can be found in the Modern Corporation Statement, an expert opinion produced by the Modern Corporation Project – themoderncorporation.wordpress.com/company-law-memo. This really is worth a look, for two reasons.  Firstly, it is a genuinely well-written article about the fundamentals of corporate law, and how some of these fundamentals are not understood.  The Statement explains difficult issues with great clarity.  Secondly, it has given rise to a debate in the US about the final principle in the Statement – whether directors are under a legal obligation to maximise profits for their shareholders.  This raises issues of the long-term interests of the company, short-term shareholder value, and the ‘purpose’ of the company.  This will be the subject of my next blog.

Staying out of jail

There are a number of ways in which directors can fall foul of the law, and there are also many ways to avoid this risk.  Understanding basic issues about company ownership, and directors’ duties in this area, are a very good place to start.